Davos and a sobering touch of humility

Baring their feelings . . . members of a women’s rights group protest at the Davos meeting.
Photo: Reuters

by
Bloomberg

Scarred by the worst banking crisis since the Great Depression and the hubris that preceded it, bankers, investors and policymakers who gathered in Davos, Switzerland, last week gave a guarded welcome to signs of recovery in the world economy and the endurance of the euro region.

“Optimism, but with a sober tone," was how Bank of America chief executive Brian Moynihan characterised the mood pervading the World Economic Forum’s annual meeting, even as investors were lifting the Standard & Poor’s 500 Index above 1500 for the first time since 2007.

The mood in Davos was “totally different" when stocks last reached that peak, Harvard University economics professor Kenneth Rogof says.

This year, executives from Deutsche Bank and Goldman Sachs Group were coupling upbeat assessments with warnings of economies remaining fragile and prone to policy error.

Some bankers fretted that credit bubbles may be forming as central banks pump out cash.

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“The crisis gave them a bit of an inoculation psychologically because they can see what can go wrong," says Rogoff, a former International Monetary Fund chief economist, after a private session with IMF managing director
Christine Lagarde
and Deutsche Bank co-chief executive Anshu Jain. “They’re not as euphoric as they’d usually be when the stockmarket went up as much as it has."

Such humility was rare in Davos on the eve of the credit crisis that engulfed markets in 2008. The year before, John Thain, then chief executive of NYSE Group, said “the financial markets, the world economies are all actually in quite good shape". Josef Ackermann, then CEO of Deutsche Bank, said investment banks “have a very good future."

Burnt by the subsequent collapse of Lehman Brothers, more than $US1 trillion in bank losses, the stigma of taxpayer-funded bailouts and a worldwide recession, leaders of the largest banks displayed little bravado in the Swiss resort this year, even as markets cheered improving economic growth in the US and China and reflected an ebbing risk that a euro member country might abandon the currency.

The MSCI World Index of stocks has climbed 5 per cent this year and is up 13 per cent from a year ago. During the week of the Davos conference, US stocks capped the longest stretch of daily gains since 2004.

On January 18, it was revealed China’s economic growth accelerated for the first time in two years. In Europe, investors have become less anxious about the euro region’s most troubled members.

The extra yield investors demand to hold Spanish 10-year bonds over German bunds has narrowed to 354 basis points from a euro era record of 638 basis points in July. Greece’s benchmark ASE stock index has surged 73 per cent in the same period.

“We’ve chewed through a lot of the problems and I would say my investing self tells me that the worst is over," says Goldman Sachs chief executive Lloyd Blankfein. But “this wouldn’t be the first time that I’ve suggested the worst was over only to find out that there was a bit of a relapse".

A recurring theme in corridor conversations at the conference was that markets were buoyed by monetary easing, which has pushed down interest rates and spurred investors to take more risk in search of returns. Market gains could prove fleeting once central bank policy reverses, attendees say.

“The world has been over-reliant on central bankers, they are the new superheroes," says Jain. “Governments and business leaders need to pick up the slack" after central banks created an “artificial glut of plenty".

Bank of Canada governor Mark Carney, who will take over the Bank of England in July, rebutted suggestions monetary policy is “maxed out". There’s still room for stimulus in the richest nations, and central bankers should be aiming to propel their economies into “escape velocity".

Billionaire Ray Dalio, whose Bridgewater Associates is the world’s largest hedge fund with $US130 billion under management, says low interest rates will trigger a shift of capital into riskier assets, making 2013 a “game changer" for the economy.

Moynihan says any policy reversal by central bankers that causes a rapid rise in interest rates could rattle markets. “If rates move too fast, it will cause shocks in the system," he told Bloomberg Television’s Erik Schatzker in Davos. “I’m not sure it’s a high probability, but we worry about it."

Political gridlock in the US was another challenge identified by delegates including Barry Eichengreen, a University of California at Berkeley economist. A clash over how to tackle the debt ceiling could be enough to hurt the dollar’s safe-haven status, he says.

Elsewhere, the economies of Japan and Britain are shrinking while the IMF last week cut its estimate for global growth this year to 3.5 per cent from 3.6 per cent.

The euro area, Japan and Britain are all contracting, says Bank of Israel governor Stanley Fischer. “That means you better not make mistakes," he says. “Relative to a year ago, we should feel much better. Should we think we are out of the woods? No."